Collective Defined Contribution (CDC) Pensions - Coming Soon Earn 50% more in retirement!

michaels

Not sure if we have discussed these yet so apologies if we have and please merge or delete.

Retiring at 67, part of the reason that an SWR is about 4% is because we need to make sure that the money lasts even if we live to a 98th percentile age of 97, so a 30 year retirement, rather than just budgeting for average longevity of 17 years. If we were able to do the latter the SWR might increase towards 6% - or 50% more income every year.

There are of course already products that pool longevity risk, annuities, but the gains from pooling life expectancy are offset by the additional costs of the insurance company buying assets that give a guaranteed payout rather than taking any market risk.

Which leads to the suggestion of Collective Defined Contribution pensions. These are bought into like annuities, pool risk in the same way but give higher returns because they continue to take some market and inflation risk as happens already with an SWR drawdown. Simply by pooling longevity risk the average return is higher.

It is anticipated that returns will likely outperform an index linked annuity although this will not be smooth, the normal downside would be no cost of living increment with a once in 30 year market downturn leading to a 5% fall in nominal income.

What is the cost to the pensioner of this magical higher return? That is a probable lost inheritance pot. Because the SWR aims to not go broke in a worst case scenario, in the vast majority of scenarios it leads to some capital being left over on death (often lots of capital). Like an annuity, with a CDC there is no inheritance pot once the CDC has been bought.

CDCs are potentially going to be available from 2027 or 2028 so if they might work for you it might be worth holding off on an annuity purchase until then

michaels

Other advantages of a CDC

CDCs are envisaged to be multigenerational rolling funds with current workers contributing directly into a CDC as they might a DB pension and then drawing down on retirement, rather than people simply buying in using a DB pot. This has the advantage of giving opportunities for smoothing of payouts and also for the funds to be invested in extremely long term stable assets such as infrastructure funds, which again potentially gives higher returns than a fund that has to provide stable annual income to a single aging cohort.

michaels

So how about on retirement rather than buying an annuity or following an SWR strategy, instead you buy into a CDC to give the same annual payment - given the 6% return compared to 4% only 67% of the fund would be need to give what would currently be your expected annual retirement income, leaving 1/3 of the pot as a potential inheritance or an emergency fund for the years where the CDC did not perform.

OldScientist

It will be interesting to see what terms the 'Retirement CDC' (i.e., one bought at retirement) will be when the legislation is introduced later this year. My understanding (which could be faulty), is that income will be regular (like an annuity) but subject to variation (unlike an annuity) and won't be index linked. However, I suspect the variation in income will be less than running many DIY dynamic withdrawal strategies since the CDC supports both accumulators and decumulators (i.e., can probably afford to smooth out short term variations). For example, the Royal Mail CDC plan states that "In the event that decreases of more than 5% are needed, they’ll be spread over two or three years (on 31 March each time), so the reduction in everyone’s income for life won’t happen all in one year."

My understanding (again, possibly faulty) is that bulk annuity providers already invest in illiquid assets like infrastructure.

mrklaw

private sector or public sector only? anywhere we can read more? if they’re due next year I’m surprised we haven’t heard about this everywhere - this is the first I’ve ever heard of them.

dunstonh

I believe the Royal Mail workplace pension is the only CDC scheme currently in the UK.

michaels

Here is the govt consultation paper

Retirement Collective Defined Contribution pension schemes - GOV.UK

They will be for the private sector, probably as an alternative to a personal pension for the compulsory employer and employee contributions.

michaels

I suspect the majority of the gain comes from the pooled longevity risk (at the expense of a possible inheritance if used instead of drawdown, no difference for this if used instead of an annuity).

I had various concerns about the fund risk (if new business dries up then the fund will need to restructure to look more like a single period annuity severely denting returns) and whether the smoothing decisions might lead to intergenerational unfairness but it seems like these have at least been considered.